When creating estate plans, people generally take their children and grandchildren into consideration and plan accordingly. For those who would like to plan beyond the next two generations, using a dynasty trust may be the answer.

A dynasty trust can preserve substantial amounts of wealth — and potentially shelter it from federal gift, estate and generation-skipping transfer (GST) taxes — for generations to come. Plus, it can provide various other benefits and protections for families for an extended period (perhaps forever).

Establishing and funding a dynasty trust

A dynasty trust can be established during your lifetime, as an inter vivos trust, or part of your will as a testamentary trust. With an inter vivos transfer, you’ll avoid estate tax on any appreciation in value from the time of the transfer until your death. Generally though, with an inter vivos transfer, the assets won’t be eligible for step-up in basis at your death.

Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests. Ensure you retain enough assets in your personal accounts to continue to enjoy your lifestyle.

Factoring in taxes

Previously, dynasty trusts were primarily used to minimize transfer tax between generations. Without one, if a family patriarch or matriarch leaves assets to adult children, the bequests are subject to federal estate tax at the time of the initial transfer to the second generation, and then taxed again when the assets pass from the children to the grandchildren, and so on. Although the federal gift and estate tax exemption can shield the bulk of assets from tax for most families, the top federal estate tax rate on the excess is 40% — a hefty amount.

Furthermore, the GST tax applies to certain transfers made to grandchildren, thereby discouraging transfers that skip a generation. The GST tax exemption and 40% GST tax rate are the same as they are for regular gift and estate tax.

With a dynasty trust, assets are taxed just once, when they’re initially transferred to the trust. There’s no estate or GST tax due on any subsequent appreciation in value. This can save some families millions of tax dollars over the durations of their trusts.

When the assets are subsequently sold, any gain will be taxable. Note that the basis of the assets will be determined at the time of the initial transfer, although depending on the circumstances, the “step-up in basis” rules may help reduce the taxable amount.

Recognizing nontax benefits

Regardless of the tax implications, there are many nontax reasons to set up a dynasty trust. For example, you can designate the trust’s beneficiaries spanning multiple generations. Typically, you might provide for the assets to follow a line of descendants, such as your children, grandchildren, great-grandchildren, etc. You can also impose certain restrictions, for example, limiting access to funds until a beneficiary graduates from college.

Planning for your family’s future

A dynasty trust creates a legacy that will live on long after you’re gone. Be aware, however, that a dynasty trust is irrevocable. In other words, you can’t undo the arrangement if you have a sudden change of heart. If you’re going to chart the course for future generations, you must have the courage of your convictions. Contact us or visit our related service page for guidance.

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